Rising rates, falling markets; how to invest in the current scenario?

How to create a portfolio to tide over rising interest rates? Prateek Agrawal of ASK Investment Managers explains 

The Reserve Bank of India (RBI) increased the repo rate by 90 basis points in the last two monetary policy meetings to control soaring inflation, which is also one of the major concerns for the Indian equity market. Considering the present volatility on Dalal Street, Prateek Agrawal, Business Head, and CIO, ASK Investment Managers shared his views with Business Today on the right investment strategy amid rising interest rates and falling equity markets. He also explained how investors can increase their chances to win in the equity market. Excerpts. 

Business Today (BT): How do you see rate-sensitive sectors amid expectations of further rate hikes by RBI in the upcoming MPC meetings?               

Prateek Agrawal: On an increase in interest rates, the impact would be negative on interest rates sensitive sectors like real estate and autos. Banks would benefit on the margin on higher net interest margins (NIMs) while treasury would take a one-time hit. General insurance companies who make profits through investment gains would see some stress. 

That said, some of these spaces are currently tackling other issues. For example, autos (cars) are tackling the supply chain issue and have significant waiting periods. If supply issues are taken care of the positive impact of the same would negate the negative impact of higher interest rates. 

Higher profits in agriculture should be expected to increase rural incomes by more than interest cost increase. In urban India, spaces that are getting wage increases in the current period should also do well. In this scenario, while higher interest rates are negative, the other factors also need to be considered. 

BT: Benchmark equity index BSE Sensex has fallen 5 per cent in 2022 so far till June 10. By when do you think bulls will again take control on D-Street? 

Agrawal: Inflation and the policy response to inflation is a large cause of worry in the market. Inflation is forcing the central bankers to tighten monetary policy faster than otherwise and this has implications for asset prices.  

However, inflation at some point would peak, unless the prices of fuels and Agri commodities keep increasing. At the same prices next year, the inflation reading would be zero and we need to appreciate that. If two large causes of inflation viz higher fuel prices and supply chain disruptions ease out, the outlook can change sharply for the positive. The Russia-Ukraine situation sorting itself out can result in fuel prices falling sharply as sanctions ease out. 

Uncertainty on the timelines of the stress period is what the market is digesting. Our country is well-positioned to withstand shorter periods of stress. The government is trying to shield the population from inflation stress to some extent. However, elongation of the stress period would mean higher transmission and consequently a higher impact on businesses. 

A sharp tightening of monetary policy should be expected to hurt the markets as it would be seen to be impacting growth negatively. We did not see the excesses that the West had in response to Covid and our normalisation process should also hence substantially lag the west.  

Apart from fuel which impacts us negatively, higher prices of Agri produce and metals do impact us positively. The purchasing power in the hinterland should be expected to improve as a consequence and this should help business buoyancy. The fact that employees are getting good wage increases in many sectors would also help consumption demand to stay relatively stronger than otherwise. 

Valuations are now lower than 5-year averages and do present an upside in line with earnings growth. The big uncertainty is the period of stress. If the stress period elongates, then there would be damage to businesses, earnings outlook, valuations, and the level of the market. 

BT: Where do you see buying opportunities in this market? And how investors can increase the success rate in volatile markets? 

Agrawal: There are buying opportunities that have emerged. In lenders for example, the stock prices have dropped in many cases below long period averages while profit outlook has improved with lower balance sheet stress and better net interest margins (NIMS). Similarly, the speciality chemical space is seeing strong growth and offers an interesting opportunity. Users of commodities with pricing power such as consumer durables and staples are getting hurt in the present high input price inflation but would benefit as inflation peaks out. Consumers are the contra plays in the market. 

In volatile times, focusing on rich businesses with strong compounding capability is a must to improve the chances of success over the long term. 

BT: How increase in the cost of money could impact midcaps and small caps? 

Agrawal: In periods of sustained market volatility mid and small caps are seen to underperform. They may hold out better in the initial phase but if the selling pressure continues, they fall more. This space is less liquid and the impact cost is higher. The same phenomenon is seen on the upside also during better times. 

An increase in the cost of money in various ways puts pressure on valuations as does lesser availability of money. Central banks around the world are tightening and some asset price correction is to be expected. 

However, a lot is going in favour of the midcaps at this juncture. If we look at the investment themes such as broad basing of global supply chains, formalisation of the economy, offshoring, beneficiaries of the Production Linked Incentive Scheme (PLI) initiative by the government, and home improvement most of the beneficiaries are mid-cap companies. Some of the themes have gotten strengthened during this period. Make more indigenously, a higher focus on domestic manufacture of new-age defense equipment and diversification of global supply chains should be expected to see sustained stronger focus going forward and the current weakness in the market does provide a good opportunity to understand and evaluate these spaces better.    

BT: Share a few tips on creating a new portfolio for investors who are sitting on the sidelines? 

Agrawal: Overall, if the risk that the investor is willing to accept does not change much then in volatile times and times of higher uncertainty investors should be expected to focus on steadier high-quality businesses with good long-term growth prospects. Retail focussed financials, consumers with strong brand power, specialty chemical and API businesses, and hospital chains could do well. In the past, similar periods had seen auto and IT also do well. In this period, autos need to resolve the supply issues. IT services have seen a sharp cut in valuations which have now come closer to long-term averages and could be a space to offer good ideas. 

BT: What is your advice to investors whose portfolios have declined over 10 per cent during the ongoing correction? 

Agrawal: The weakness in the market is the best time when the weakness/strength of the businesses comes to the forefront. If the business that the investor is holding is of good quality and continues to do well, a drop in stock price should be seen as God sent for more accumulation. However, if some weaknesses in the business bought, come to the fore, then the investor has to take a tougher decision.